Peak Oil News: The End of Cheap Oil

Friday, July 15, 2005

The End of Cheap Oil

t r u t h o u t

By Yves Cochet

The daily or weekly fluctuations in the price of a barrel of crude oil on the New York market are due to a multitude of factors of very different origin and bearing.

Commentators usually cite OPEC output, the state of American commercial stocks, the weather, speculators, terrorism, weakness in refinery capacity, the situation in Iraq, in Iran, in Nigeria, in Venezuela, in Russia ...

But these "explanations" appear valid whatever the level of the barrel price - 30 dollars, 40 dollars, 50 dollars... - while we lack the principal explanation for the level itself, today 60 dollars. Three decisive factors are pushing the price of crude up permanently: the geological depletion of conventional oil (inexpensive to extract), the entry into a world of terrorism and of permanent wars for the control of oil, the strong increase in demand due to Asian growth and the maintenance of Western consumption. It's traders' anticipation of this last factor that heats up the price today.

During the first century and a half of the oil era - from 1859 to 2004 - global demand was always satisfied by the supply. You wanted more oil? We had margins of maneuver. We would open up the spigots. More flowed out. We sold more.

The oil shocks of yesterday were political, not economic. Today, while average global demand in 2005 will border on 84 million barrels a day (Mb/d), the room for maneuver on the supply side is practically non-existent.

All the spigots are delivering at their maximum capacity, at the limit of demand and at the risk that an event (strike, sabotage, local conflict) reduce supply. A situation of relative shortage results, pushing prices higher.

As long as the supply does not satisfy demand, the price of oil will increase until a sufficient number of consumers - there are billions of them! - adjust their consumption to the possibilities of their budget. If global supply reaches the limit of 84 million barrels a day (Mb/d), prices will stabilize at the level necessary for consumption not to exceed those 84 Mb/d. And when geologic depletion accentuates, the absolute decline in global supply will take place at a rate of at least 2% a year. Prices will then have a tendency to increase still more to exclude more consumers and reduce consumption.

However, the long oil-dependency of many countries makes me think that demand will remain strong for vital reasons. The pursuit of growth and the increase in global population will continue to feed an increase in demand along the order of 1.5% a year. In fact, statistics show that oil demand is relatively price-inelastic (unlike demand for strawberries). In other words, it's not because prices will increase that demand will decrease.

In 2004, demand grew more than 3.5%, or 2.7 Mb/d - the biggest increase in twenty-five years - while the average price for a barrel of oil went from 26 dollars in 2002 to 31 dollars in 2003 and 41 dollars en 2004. From the beginning of 1999 up to the end of 2004, the price of crude increased 350% and demand 10%, contrary to all predictions. This phenomenon could almost be called reverse inelasticity: demand grows while prices increase. Nonetheless, this surprising "rule" only obtains up to a certain level of prices, for a moderate speed of increase and over a limited period of high prices.

Another conventional and false belief postulates that high oil prices slow the economy down. The contrary may be observed: rather high prices tend to push global growth, which in 2004 was at its strongest in fifteen years. In effect, while the price of the barrel rises, considerable volumes of petrodollars received by the oil companies, both the private ones and especially the nationalized ones, are recycled into purchases of raw materials, finished products, or agricultural commodities from countries exporting those goods, which are different from the oil-exporting countries. Global commerce grows, involving even certain poor countries which rapidly transform the proceeds from their sales of raw materials into purchase of the manufactured goods they lack. These countries do not save and possess a strong marginal propensity to consume. Any supplementary revenue is converted into imports of what they don't have.

This schema applied to the little Asiatic dragons, Singapore, South Korea, and Taiwan during the 1970s, when oil prices went up by over 400% between 1973 and 1981. Today it corresponds to the boom in China, India, Pakistan, and Brazil. Global oil demand is therefore only slightly linked to the level of crude prices in New York - up to a certain level and up to a certain speed of increase, at any rate.

An oil shock can, with a time-lag, provoke a slowdown or a recession in one region of the world and simultaneously stimulate the economy in another region. It's globalization as a planetary dynamic that counts, not the energy savings of some Northern countries, cancelled out by the energy voracity of some emerging countries. In total, a transfer of Northern countries' energy-intensive activities to emerging countries joins an increase in global merchandise traffic to increase total energy consumption. The so-called post-industrial "knowledge economies" of the OECD rest on a massive transfer of their material and energetic foundations to "emerging economies."

If prices continue to rise fast for underlying reasons, at 70 or 80 dollars a barrel it is likely that the inflationary consequences of the oil price rise will be sufficiently marked for the central bank governors of rich and oil-voracious countries - North America, Japan, and the European Union - to raise interest rates in an attempt to contain inflation.

That remedy will only increase the pain, reactivating the pain we already experienced during the second oil shock of 1979-1983, under the ultra-liberal impetus of Margaret Thatcher and Ronald Reagan. In fact, when the cost of money increases, financial markets contract and businesses have more difficulty financing themselves on the Stock Exchange or loan markets, which slows down economic activity. When money is more expensive, everything becomes more expensive, and inflation increases.

When they attempt to arrest it by a second method, banks print more money, which provokes the opposite result: more inflation. Consequently, the method of raising interest rates, supposed to fight inflation, on the contrary, brings about the contraction of financial markets, inflation in the cost of money, then of other prices, the destruction of employment and business difficulties.

Oil is less a final product than a factor of production, often a small factor in total cost. The consequence of this is that, for the moment, there are few incentives to substitute for oil or to reduce demand. Even climatic change and its lethal effects have not dissuaded the buyer of a 4x4 whose grandmother died in the summer 2003 heat wave.

This relative rigidity will aggravate the seriousness of the economic and social consequences of the triple shock that is on the way. Since no one is prepared, it will be grave. Because, this time, there will be no long return to a reduction in prices, to low-priced oil products. Inflation is likely to be severe, the recession also.

What I am talking about here is not "the end of oil," but "the end of cheap oil." That, alas, will be enough to provoke enormous economic and social instabilities, to dislocate political powers, and to provoke wars. The misfortune is that, in spite of the warnings shouted out by some, political and economic leaders have not at all anticipated the coming situation, as is demonstrated by the undeserving proposed law on energy orientation adopted by the National Assembly Wednesday June 23. The shock is inevitable. There is no plan B. There is only a half-solution - immediate sobriety - to reduce the devastating impacts of the shock by pushing back a little its inevitable arrival.

Yves Cochet is a Paris Green Deputy and former Minister for Land Settlement and the Environment.

Translation: t r u t h o u t French language correspondent Leslie Thatcher.


At 11:00 AM, July 18, 2005, Anonymous Anonymous said...

Very nice description how the 'economy' grows while resource depletion continues. Likely all of the global deregulation of industry and liberlization of trade has provided us with a $20 power drill at Big Box stores. But has had the effect of increasing the rate of growth in depletion in the underlying resouces need for the economic wonder of the past 20 years.

While 'us' enlighted are likely correct it may take a long time to play out. Say 10 or 20 more years. May say it sounds like crying wolf.


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